Comparing the Producer Price Index for Personal Consumption with the U.S. All Items CPI for All Urban Consumers

It is sometimes assumed that the direction and magnitude of price changes in the Producer Price Index (PPI) will anticipate or parallel similar changes in the Consumer Price Index (CPI) for All Items. When this assumed relationship is contradicted by actual index changes, many data users ask why the PPI and CPI show different price movements.

The answer is that conceptual and definitional differences between the PPI and CPI—differences which are consistent with the uses of the two measures—contribute to the differences in their price movements. A primary use of the PPI is to deflate revenue streams in order to measure real growth in output. A primary use of the CPI is to adjust income and expenditure streams for changes in the cost of living. The different uses result in definitional differences that can be categorized into three critical areas: (1) scope and coverage, (2) categorization, and (3) other technical differences.

Within the PPI, the index that most closely aligns with the CPI for All Items is the Personal Consumption PPI, a substantial component of Final Demand within the PPI’s primary aggregation model, the Final-Demand-Intermediate Demand system. In terms of goods, the PPI for personal consumption tracks changes in manufacturer selling prices for consumer foods, consumer energy goods, consumer durable goods, and consumer nondurable goods other than food and energy. From the services perspective, the Personal Consumption Index tracks changes in prices received by services producers for transportation of private passengers, transportation and warehousing of personal consumption goods, wholesale and retail trade in personal consumption goods, and services other than trade, transportation, and warehousing sold to personal consumption. The All Items CPI for All Urban Consumers (CPI-U), U.S. city average, measures the average change in prices urban consumers pay for goods and services.

Scope and coverage

The scope of the PPI for personal consumption includes all marketable
output sold by domestic producers to the personal consumption sector of
the economy. The majority of the marketable output sold by domestic
producers comes from the private sector; however, government produces
some marketable output that is within the PPI’s scope. In contrast to
the PPI’s scope, that of the CPI includes goods and services provided by
business or government when explicit user charges are assessed and the
goods or services are paid for by consumers.

The most heavily weighted item in the All Items CPI, owners’ equivalent
rent, accounts for approximately 24 percent of the overall index. Owners’
equivalent rent is the implicit rent that owner occupants would have to
pay if they were renting their homes and is included in the CPI in order
to capture the cost of shelter for owner-occupied housing units. The PPI
for personal consumption does not include owners’ equivalent rent within
its scope, because owners’ equivalent rent is not a domestically produced,
marketable output.

The PPI for personal consumption and the CPI also differ in their treatment
of imports. The CPI includes within its scope goods and services purchased
by domestic consumers and therefore includes imports. The PPI, in contrast,
does not include imports, because imports are by definition not produced by
domestic firms. Imports compose a substantial portion of the CPI, especially
within the apparel and new-cars component, and their inclusion in the CPI
and exclusion in the PPI for personal consumption causes a substantial
difference between the two indexes.

The CPI includes only components of personal consumption that are directly
paid for by the consumer, whereas the PPI for personal consumption includes
components of personal consumption that are not paid for by the consumer.
For example, the PPI for personal consumption includes medical services that
are paid for by third parties such as employers or the federal government.
The CPI, by contrast, includes only payments made directly by consumers for
medical care. In December 2011, medical care services composed 23.1 percent
of the PPI for personal consumption but only 5.3 percent of the All Items CPI.

A final difference in scope between the PPI and the CPI occurs for services
whose prices contain an interest rate component. The CPI’s scope excludes
changes in interest rates or interest costs. The scope of the CPI includes
services, such as banking services and insurance services, whose prices have
an interest rate component, but the interest rate component of these services
is not included in the index. The scope of the PPI also encompasses services
whose prices include an interest rate component, but this index includes the
interest rate component of those prices. Banking services account for
approximately 4 percent of the PPI for personal consumption, and insurance
services compose 3.8 percent. Within the PPI, changes in interest rates will
affect price indexes for banking and insurance. The scope of the CPI includes
some banking services, such as ATM fees, and many insurance services; however,
the interest rate component of these services is not included. Changes in
interest rates therefore do not affect the CPI.

In contrast to the CPI, the PPI does not currently have complete coverage of
services. In the mid-1980s, the Bureau began expanding PPI coverage beyond
mining, manufacturing, agriculture, and utilities, introducing its first
services price index in 1985. The effort to expand coverage into the services
sector of the economy is ongoing. The PPI currently covers approximately 72
percent of services, as measured by 2007 Census revenue figures for the
sector. Because the PPI does not have complete coverage of services, a number
of services are included in the CPI that are not included in the PPI for
personal consumption. Among the most important of these services are residential
rent, accounting for approximately 6.5 percent of the CPI, and education
services, composing slightly more than 3 percent of the CPI.

Categorization

The PPI and the CPI categorize a number of goods and services differently
within their index structures. Differences in categorization for goods and
services are mitigated at high levels of aggregation but can create discrepancies
at lower levels. The PPI, for example, classifies utilities, such as electric
power and natural gas, as goods, while the CPI categorizes utilities as services.
The overall PPI for personal consumption and the CPI both include utilities;
however, the PPI for personal consumption services excludes utilities, while
the CPI for services includes utilities, making the two services indexes less
comparable than the overall indexes.

The PPI and the CPI also differ in their categorization and treatment of trade
and transportation. The PPI generally separates the costs of transporting,
retailing, and wholesaling goods from the cost of the good itself and classifies
trade and transportation as services. In contrast, prices for goods as measured
by the CPI typically include the value of the good, the value of transporting the
good, and the trade margins associated with the sale of the good.

Other technical differences

Several other technical differences exist between the PPI for personal consumption
and the CPI. The PPI and the CPI are both constructed with the use of a modified
Laspeyres index formula, but the CPI updates weights every 2 years and the PPI
updates weights every 5 years. The CPI also implements a geometric mean formula
at the item level that the PPI does not. The geometric calculation reduces
substitution bias, leading to lower measures of inflation in periods of price
increases. The PPI attempts to collect prices for a specific day of the month
(the Tuesday of the week containing the 13th), while the CPI collects prices
throughout the month. Finally, prices measured by the CPI include sales and
excise taxes, while prices measured by the PPI exclude those taxes.